Bankruptcy is designed to provide a fresh start for those in dire financial straits. But that second chance comes with a catch: that new beginning starts at the bottom of a deep hole.
That’s because bankruptcy, not surprisingly, has a huge negative effect on an individual credit rating. As a result, credit instruments that most people take for granted – such as credit cards and loans – are much more difficult to obtain. But, fortunately, difficult doesn’t necessarily mean impossible.
There are two types of bankruptcies: Chapter 7 and Chapter 13. In both of these instances, the court will appoint a trustee and create a bankruptcy estate to pay off creditors over a given period of time. Chapter 13 bankruptcies provide more flexibility in terms of getting new credit. When it comes to climbing out of bankruptcy, the temptation of credit cards can be counterproductive. In addition, since all new credit for those in bankruptcy must be court-approved, the chances of a getting a card with a high credit limit are slim.
A loan, however, can be a necessity and, as such, more likely to be approved by a bankruptcy trustee or court. For example, it’s not uncommon for individuals to need a new car during their bankruptcy. Financing for a car loan can be provided by the dealer. But loans for someone in bankruptcy will tend to be for a smaller amount with shorter terms. In addition, interest rates are much higher on these loans. The exact terms depend on the financial situation of the borrower, such as current income and the details of their bankruptcy payment plan.
But, before a loan can be secured, it must be court-approved. Borrowers must submit the terms of the loan, the source of the down payment and how the installment payments will figure into the budget that the bankruptcy court has approved. The bankruptcy trustee – or an attorney — has to sign off on the plan and present it to the judge for approval. It’s important to note that this process can take at least a month, so borrowers should plan accordingly.
This process applies to all potential loans and credit applications that may arise under bankruptcy. For larger and more complex loans, such as mortgages and home improvement loans, borrowers may stand a stronger chance of approval if they’ve completed a year or two of payments under their court-ordered bankruptcy plan. The stronger the borrower’s financial position, of course, the better the chance of the loan being approved.
Other unexpected expenses may require revisiting the original bankruptcy budget plan. Emergency home repairs, medical and tax bills are examples of these sorts of emergencies. In these cases, a line of credit – or credit card — can be more appropriate than a loan. But, just as is the case with a loan, a case will have to be made in court that the additional credit is necessary. If approved, the new credit will likely have to be secured. A secured credit card requires the owner to make a security deposit in order to be approved. The amount of this deposit then becomes your credit limit.
While this amount is typically smaller than the limit on an unsecured card, secured cards offer a useful method for those in bankruptcy to restore their credit by making their payments on time. Over time, a strong payment history can borrowers qualify for more and larger amounts of credit both during and after bankruptcy.